~ Investment Strategy

Morning Note 06/02/12

I don’t have anything to add to the newsflow here, but it seems that Greece’s politicians have sort-of agreed to further spending cuts of 1.5% of GDP this year and on a framework for bank recapitalisations. However, they have not agreed to all the measures that the Troika is demanding, including labour market reforms. Mr. Samaras, the leader of New Democracy, complained that the Troika was asking too much of Greece and that an even-worse recession was not the way out of Greece’s problems. In fact, given the tough line taken by the Troika, it is the only way out of Greece’s immediate problems. Politicians have to look like they are opposing EU-driven austerity, but they are likely to give in rather than risk an uncontrolled default and sharp fiscal contraction. I still expect the Greek restructuring to be put to bed and a new aid package to be agreed in Q1.

Canada

The Economist (http://econ.st/xMcn8h) speculates that Canada’s housing boom may be close to its end. It could well be worth looking into this and I plan to do so this week. CDS on construction companies and banks might be ways to play it. Interest-rate options and the CAD do not seem like ways to play it. With short-term interest rates at 1% there is not much room to benefit from rate cuts and in addition any increase in interbank spreads could overwhelm the effect of any rate cuts on short rates; and the CAD could rise if the Iranian situation causes an increase in oil prices.

Iran

It is important not to lose sight of the Iranian situation. Leon Panetta, America’s Defence Secretary, has said that some kind of Israeli strike on Iran is possible in the first half of this year. While Benjamin Netanyahu is not especially popular in Washington, D.C. for his hardline attitudes, his Likud party remains the front-runner in Israeli opinion polls and he leads his nearest opponent by 38.5% to 12.2% for the “most appropriate” next prime minister. That seems to suggest that he is popular enough to carry out a strike. Perhaps on account of this, there is a proposal in the US Congress to cut off anyone who is involved with Iranian oil exports from the US banking system, which would be a pretty effective form of embargo; in the short term, the Senate Banking Committee has already ordered the administration to investigate possible links between Iran’s oil companies and the Revolutionary Guard. Whether a strike actually happens or whether ever-harsher sanctions regimes are introduced to prevent it, it strikes me that the risks to Brent are very much to the upside. That is an important downside risk for global growth.

Finland

The candidate of the ruling National Coalition has won the Finnish presidential election with 62.6% of the vote. This is an important victory for a pro-European candidate in a campaign dominated by European issues. The main opposition parties had called for Eurozone exit. The candidate of the Finns party, a nationalist outfit, won only 9% of the vote. One should not underestimate the emotional attachment of European populations to the EU project, or the importance of the nebulous (and, in my view, unfounded) fear of being “out”.

European Banks

The FT reports that the EBA is likely to reject a decent proportion of the recaptalisation plans submitted by European banks in connection with the requirement that they raise their CT1 ratios to 9%. Only one bank is planning a rights issue; others plan to rely on retained profits and buying in their debt at a discount. These methods should pass muster. What may not are plans to change risk-weighting calculations and to sell assets for which buyers are unlikely to emerge. If banks are prevented from using these methods, they will clearly fall back on retained profits rather than rights issues, with further negative implications for the Eurozone credit environment.

Construction Turning Around?

Calculated Risk (http://bit.ly/AC6ojx) reports that construction employment appears to have turned around. It increased by 21,000 in January, after rising 74,000 in the whole of 2011. CR points out that the bottoms in construction and house prices tend to come in that order; it may be that house prices will turn around this year. Of course, it is far from clear that the present general recovery in the US economy will continue; but the risk-reward ratio on underpriced US construction firms may be turning around.

US Data

Relatively strong labour-market data in the US (see below) have reduced, at the margin, the chance of QE3. The Fed’s unemployment forecast sees the number at 8.2-8.5% by the end of this year, but it turns out that we are already at 8.3%. The big questions of the moment are 1) does it matter whether the Fed actually does QE3, since it has signalled that it will if the environment deteriorates and that could be enough to buoy risk assets (i.e. is there a Bernanke put on the unemployment rate?); and 2) if it does matter, will the Fed wait until the situation deteriorates, or does it already think the situation is bad enough to do QE3? On the first question, I tend to think that it doesn’t matter — i.e. that a signalled willingness to do QE is almost as good as the real thing. On the second, I think that things are bad enough for the Fed to act regardless of any marginal improvement in the labour market. But I am less sure on the second point, and in any case the crucial point is the first one: the Fed has already eased and at the least created a Bernanke put, and that should be positive for risk assets.

Data

Non-farm payrolls 243k b.e. Jan. Revisions to past data added another 266k to total payrolls. The employment/population ratio appeared to be flat on account of the annual revision to the denominator, but using the old denominator the ratio increased.